The Prevailing View on Prevailing Wages

Recently enacted California legislation impacts when a private development project will be classified as a "public work," triggering the payment of so-called prevailing wages. Prevailing wages are hourly work rates published quarterly by the California Department of Industrial Relations (DIR) as the minimum wage rates payable to construction workers employed on public works in California. Prevailing wage requirements can escalate labor costs by 5% to 15%, or higher. Contractors who fail to pay prevailing wages face retroactive liability for the difference between wages actually paid and the prevailing wage rates applicable to the trade employed.

The purported intent of the prevailing wage statutes is to ensure that workers are paid "the generally prevailing rate" of wages for their work where performed and to maintain public construction quality when agencies are required by law to contract with the lowest responsible competitive bidder. Setting minimum wage rates for all contractors theoretically keeps local contractors, who hire local employees and pay wages customary in the area, competitive with contractors using low-wage, non-local employees. In most of California, the published prevailing wage rates are the union wage rates for commercial and engineering construction work for governmental projects. These rates are often significantly in excess of wages for workers employed in private residential and commercial construction.

Since their inception, California's prevailing wage statutes have been applied generally to "fixed works of construction for public use." In 2001, the DIR redefined "public work" to include work "paid for in whole or in part out of public funds." This pronouncement served to muddy the issue of whether private construction projects that include the construction of public improvements - as well as private construction projects receiving the equivalent of public funds, such as bond financing or redevelopment tax increment - are public works for which the payment of prevailing wages is required.

For a host of economic and policy reasons, the real estate industry and public sector constituencies objected to the DIR's pronouncement. In response, the Building Trades Unions sponsored Senate Bill 975 ("SB 975") to codify the DIR's pronouncement. At first blush, SB 975 applies prevailing wages to both construction of improvements for use by the public and to private projects that receive the benefit of "public funds." The term "public funds" includes a contribution to a construction project by a California state or local agency, including (i) waivers, reductions or payments of fees, costs, rents, insurance or bond premiums, (ii) discounts in interest rates or other loan terms, and (iii) transfers of property for less than fair market value.

During the legislative process, however, a variety of important exceptions to the prevailing wage requirements were added to SB 975 which appear to prove the old adage: the exception makes the rule. SB 975's exceptions, detailed below, should make most developments in California exempt from prevailing wage requirements:

Residential projects are excluded from prevailing wage requirements if they are not built under an agreement with a redevelopment agency, local public housing authority or a state agency.

All private projects (including residential projects facilitated by an agreement with any agency) are relieved of prevailing wage obligations if the public funds received by the private developer are simply reimbursements that do not exceed the cost of public improvements that the developer is required by the public agency's discretionary approval process to install during the project, provided that the developer must pay prevailing wages on the public improvements constructed.

Policy exclusions are also provided for projects receiving public funds from specific programs, such as low and moderate income housing funds, residential tax credits, affordable housing bonds, single-family mortgage revenue bonds, veterans bonds and mortgage credit certificates. Some of these policy exclusions (such as for affordable housing) have one-year sunset provisions, and will no doubt be the subject of lobbying efforts for extension by interested parties.

Given the amount in controversy and the already high cost of development, the real estate industry and public agencies will soon challenge the DIR's prevailing wage schedules. Meanwhile, the jurisdiction in which one develops may be more important than ever, since charter cities (as contrasted with general law cities) may be exempt from the prevailing wage statutes unless the public work is "let out to contract." The phrase "let out to contract" is commonly understood to mean to award a contract after bids have been submitted. Therefore, in a charter city jurisdiction where completed public improvements are acquired from a private developer and no contract is awarded for the performance of the public work, prevailing wage statutes are inapplicable to non-public improvements and applicable to public improvements only pursuant to local policy constraints. Such is presently the case in the context of bond financed projects such as Mello-Roos, assessment or conduit borrowings, where the developer does not ordinarily construct improvements "let out to contract." Rather, an acquisition agreement, contribution mechanism or loan agreement forms the basis for payments.

Even in the context of a general law city, creative application of the Subdivision Map Act discretionary entitlement process can serve to minimize the payment of prevailing wages on private projects, including those for which public bond moneys and property tax increment are made available. Under SB 975's second exception, where approval of an otherwise private development project is conditioned upon the construction of public improvements and the state or political subdivision does not contribute any more money to the project than is required to perform the public improvement work and does not maintain any proprietary interest in the overall project, then only the public improvement work is subject to the prevailing wage statutes.

The true impact of SB 975 on public-private partnerships will be determined over time, as the DIR and the courts provide their interpretation. Until then, there are bound to be heated disagreements over the meaning of SB 975, with labor on one side and the development community on the other. It will be interesting, to say the least, as to which side will "prevail."

Lew Feldman is the Managing Partner in the Century City office and may be contacted via e-mail at lfeldman@pillsburywinthrop.com or by phone at (310) 203-1188.

Diane Young is an associate in the Century City office and may be contacted via e-mail at dyoung@pillsburywinthrop.com or by phone at (310) 203-1127.

Pillsbury Winthrop LLP is a global law firm with power and presence on both U.S. coasts and abroad, with core practice areas in: real estate, litigation, technology and intellectual property, energy, capital markets and finance. The firm has 17 offices and approximately 800 attorneys worldwide. For further information on the firm's real estate practice, please contact Jim Rishwain at jrishwain@pillsburywinthrop.com or (310) 203-1111.